CA Final SFM Formula Booklet by CA Aaditya Jain

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ExamTips
EARNING PER SHARE (EPS)

Total Earnings Available for Equity Shareholders
 Earning Per Share (EPS)  Total Numbers of Equity Shares
DIVIDEND PER SHARE (DPS)

Total Dividend Paid To Equity Shareholder
Dividend Per Share (DPS) = Total Number of Equity Shares
MARKET PRICE PER SHARE (MPS)

Total Market Value / Market Capitalization / Market Cap
Market Price Per Share (MPS) = Total Number of Equity Shares
DIVIDEND RATE
Dividend Per Share
Dividend Rate =  100
Face Value
DIVIDEND YIELD ( RETURN )
Dividend Per Share
Dividend Yield ( Return ) = Market Price Per Share  100
DIVIDEND PAYOUT RATIO (D/P RATIO)

Dividend Per Share
Dividend Payout Ratio = Earning Per Share  100
RETENTION RATIO
 EPS - DPS   Retained Earning Per Share 
Retention Ratio =   100 or (1 - Dividend Payout Ratio) or    100
 EPS   EPS 
EARNING YIELD (EY)

Earnings Per Share
Earning Yield = Market Price Per Share
WALTER'S MODEL
r
DPS (EPS – DPS)
Symbolically : Po = K +
Ke
e Ke
OPTIMUM DIVIDEND PAYOUT OR OPTIMUM RETENTION RATIO
Walter suggested that optimum dividend payout ratio or optimum retention ratio depends on the relationship of Ke & r
Optimum
Nature of Firm Relation Dividend Payout Retention Ratio
Growth Company Ke<r 0% 100%
Declining Company Ke>r 100% 0%
Normal Company Ke =r Indifferent Indifferent
AADITYA JAIN
THE GORDON'S
BEST SFMGROWTH MODEL
FACULTY OF INDIA
DPS1 DPS0 ( 1  g) EPS(1  b)
Symbolically :Po= K – g or Po = K  g or P0  K  g or [ If EPS(1-b) is considered as D1] [Preferred]
e e e
EPS(1  b)(1  g)
P0  [ If EPS(1-b) is considered as Do] Where b =Retention Ratio (%)
Ke  g
ExamTips
PRICE/EARNING RATIO
MPS
Price Earning Ratio =
EPS
RELATIONSHIPBETWEEN GROWTH RATE ; RETURN ON EQUITY ; RETENTION RATIO

g= bxr
Note:Other things remaining constant"g" and "b" are directly related to each other
DETERMINATION OF GROWTH RATE (g)

Assuming growth rate to be constant , we can find the growth rate by using any of the following two relation :
(a) g = b  r
(b) D Latest or Current  D Base (1  g) n -1
ZERO GROWTH RATE

When company is distributing all its earning as dividend i.e when EPS = DPS [i.e no retention], growth rate will be NIL.
In such case growth model will become :
EPS
P0 
Ke
VALUE OFDECLINING FIRM/NEGATIVE GROWTH FIRM
Market Price Per Share of a firm whose dividend is declining at a constant rate p.a forever is given by
D 0 (1  g)
P0 
Ke  g
UNEQUALGROWTH RATE/VARIABLE GROWTH RATE CONCEPT
Dividend Growth Model cannot be applied directly in case where dividend is not growing at a constant rate from year 1 onwards .In
such case we will modify Dividend Growth Model and calculate Current Market Price in the following manner
P0 [ Assuming Dividend is growing constantly from year 4 onwards ]

D1 D2 D3 D4  D5  1
       
1 2 3 4
1  Ke (1  Ke) (1  Ke) (1  Ke)  Ke – g  (1  Ke) 4
OVERVALUED & UNDERVALUED SHARES

When Current Market Price[i.e price prevailing in stock market] and Theoretical(Fair OR Present Value) Market Price [i.e price which
we calculate by applying present value concept] are not same we will undertake following decision :
Case Valuation Decision
If Current Market Price > Present Value Market Price Overvalued Sell
If Current Market Price < Present Value Market Price Undervalued Buy
If Current Market Price = Present Value Market Price Correctly Valued Hold
RELATIONSHIP BETWEEN KE & PE RATIO

1
Ke 
P/E Ratio
ASSET TURNOVER RATIO (ATR)
Net Sales
Asset Turnover Ratio =
Total Asset AADITYA JAIN
Decision:Higher the better
THE BEST SFM FACULTY OF INDIA
RETURN ON EQUITY (ROE )
Return On Equity (ROE ) ( r)

Total Earnings Available For Equity Shareholder
=  100
Total Equity Shareholder' s Fund
ExamTips
BOOK VALUE PER SHARE (BVPS)
Total Equity Shareholder' s Fund
Book Value Per Share ( BVPS ) =
Total Number Of Equity Share
RELATIONSHIP BETWEEN ROE,BVPS & EPS

EPS = Book Value Per Share  Return on Equity..
CALCULATION OF HOLDING PERIOD RETURN(HPR)

D1  P1  P0  D1 P1  P0
Holding Period Return or Total Yield     Dividend Yield  Capital Gain Yield
P0 P0 P0
CAPITALGAIN YIELD
P1  P0
Capital Gain Yield =  100
P0
PRICE AT THE END OFYEAR 1
P1  P0
P1 is normally calculated by using thi  100
P0
STRATEGY WHEN INVESTOR IS ALREADY HOLDING SHARES

Actual Po > Fair Po - Overvalued Sell
Actual Po < Fair Po - Undervalued Hold
E/P RATIO OR EARNING PRICE OR YIELD RATIO

Earnings Per Share
E/P Ratio = Market Price Per Share
VALUE AS PER PE MULTIPLE APPROACH AND

EARNING GROWTH MODE
Value of stock under the PE Multiple Approach
Market Price per Share = EPS x PE
Where PE Multiple = (1/Return on Equity)
Value of the Stock under the Earnings Growth Model
EPS(1  g)
Market Price per Share =
Ke  g
VALUE AT THE END OF “N” YEAR FROM WHERE GROWT RATE BECOMES CONSTANT
D4
Assuming that growth rate becomes constant after 3 years price will be:P3 =
Ke – g
VALUE OF STRAIGHT COUPON BOND OR EQUAL COUPON BOND

Interest Interest Interest Maturity Value
  .................. 
Value of Bond (B0 ) =
(1  Yield)1 (1  Yield)2 (1  Yield) n (1  Yield)n
= Interest x PVAF ( Yield %, n years) + Maturity Value x PVF ( Yield %, n years) Where n = Number of Years to Maturity
VALUE OF PERPETUAL BOND ORJAIN

AADITYA IRREDEEMABLE BOND
Value Of Bond (B0 )  THE

Annual Interest BEST SFM FACULTY OF INDIA
Yield
VALUE OF ZERO COUPON BOND OR DEEP DISCOUNT BOND

Maturity Value
(1  Yield)n
ExamTips
VALUE OFSEMI ANNUAL INTEREST BOND
Meaning : Semi Annual Interest Bonds are those bonds which pay interest semiannually .
To value such bonds we have to make three changes :
Annual Interest Amount Yield p.a
1. 2. Years To Maturity  2 3.
2 2
HOLDING PERIOD RETURN (HPR)

I1  (B1  B 0 ) I1 (B1  B 0 )
Holding Period Return (R) or Total Return = or  or Current Interest Yield + Capital Gain Yield
B0 B0 B0
Where B o is the Price of bond as on today , and B1 is the price of the bond at the end of the holding period
Note : The holding period is generally assumed to be of one year period unless otherwise specially stated .
CAPITALGAIN YIELD
(B1  B0 )
Capital Gain Yield = 100
B0
CURRENTYIELD / FLAT YIELD /CURRENT INTERESTYIELD/
BASIC YIELD
I1
Current Yield = B Where I1 = Interest To Be Paid at Year End 1
O
YIELD ( K d ) OR YIELD TO MATURITY (YTM) OR COST OF DEBT
Symbolically : It can be calculated by using two method :
Interest Interest Interest Maturity Value
  .................. 
Trial n Error Method : Value of Bond (B 0 )
(1  Yield)1 (1  Yield) 2 (1  Yield)n (1  Yield)n
Lower Rate NPV

Now for finding Yield we should use IRR Technique :Kd = Lower Rate + Lower Rate NPV – Higher Rate NPV  Difference in Rates
 Maturity Value – Bo 
Interest p.a   
 n 
Kd p.a 
Approximation Method : Maturity Value  Issue Value
2
Where Bo is current value of bond in case of existing bond or issue price or new proceeds in case of new issue of bond
RELATIONSHIPBETWEEN BOND VALUE AND YTM

YTM and the Bond Value has inverse relationship.
RELATIONSHIP BETWEENYTM AND COUPON RATE

Case Nature Of Bond
Coupon Rate = YTM Par Value Bond i.e Bo = Par Value
Coupon Rate > YTM Premium Bond i.e Bo > Par Value
Coupon Rate < YTM Discount Bond i.e Bo < Par Value
TAXATION EFFECT ON INTEREST INCOME

If income tax rate is given in question then Interest should be taken after tax .
AADITYA JAIN
TAXATION EFFECT ON CAPITALGAIN INCOME
THE
If Capital Gain Tax Rate is given then BEST
Maturity SFMbeFACULTY
Value should taken after tax i.eOF
after INDIA
adjusting it for Capital Gain Tax
DURATION OF PERPETUAL BOND

1 YTM
Duration Of Perpetual Bond =
YTM
ExamTips
YIELD TO CALL ( YTC )
 Call Value – B o 
Interest   
 Call Years 
 YTC  Call Value  B o
2
YIELD TO PUT ( YTP )
 Put Value – B o 
Interest   
YTP   Put Years 
 Put Value  B o
2
KD OF PERPETUAL BOND
Annual Interest
 Yield or Kd 
Bo
DURATION OF NORMAL BOND OR FREDRICK
MACAULAY 'S DURATION
1  Interest Interest Interest Maturity Value 

Symbolically : Duration = B 1   2  ............n  n 
o  (1  Kd)1 (1  Kd) 2 (1  Kd) n (1  Kd) n 
Short Cut Formula:
1  YTM (1  YTM)  n (Coupon Rate  YTM)
Duration  
YTM Coupon Rate [(1  YTM) n  1]  YTM
DURATION OFA ZERO COUPON BOND

For a zero coupon bond , the duration is simply equal to the maturity of the bond
While the duration of a normal coupon bond will always be less than the maturity.
VOLATILITY /SENSITIVITY/MODIFIED DURATION

Meaning : Modified Duration is a measure of volatility.In other words , Modified Duration is a measure of % change in bond value for
every 1 % change in Yield to Maturity.
 Duration Of Bond 
Symbolically :Volatility or Modified Duration or Sensitivity [ % ] = 1  Yield To Maturity 
 
Note : % Change in Bond Price = - Modified Duration  Change In Yield To Maturity
Note : The Modified Duration will always be lower than the Macaulay Duration.
FAIR VALUE OF CONVERTIBLE BONDS AS ON TODAY/STOCK VALUE OF BOND

Fair Conversion Value or Stock Value Of Bond
= Number Of Equity Shares Received on Conversion x Market Price Per Share prevailing at the time of conversion
Decision:If Fair Conversion Value Of Convertible Bond is greater than Basic Bond Value Of Debenture,investor will convert otherwise
not.
CONVERSION RATIO
Conversion Ratio directly specifies the number of equity shares we get in place of one convertible bond.
PERCENTAGE OF DOWNSIDE RISK

Downside Risk = Market Value Of Convertible BondAADITYA
- Market Value Of Non Convertible Bond or Straight Coupon Bond
JAIN
It should be further divided by Market Value Of Convertible Bond to calculate answer in %.
CONVERSION PREMIUM
Conversion Premium or Premium Over Conversion Value
= Market Price Of Convertible Bond-Fair Conversion Value Of Convertible Bond As On Today
It should be further divided by Fair Value Of Convertible Bond to calculate answer in %.
ExamTips
CONVERSION PARITY PRICE
Market Price Of Convertibl e Bond
Conversion Parity Price =
No.of Shares on Conversion
It is the price at which premium will be 0.
CONVERSION PARITY PRICE PREMIUM PER EQUITY SHARE

IN Rs: [Also Known As Conversion Premium Per Share ] = Conversion Parity Price of Equity - Actual Market Price of Equity
Conversion Parity Price of Equity - Actual Market Price of Equity
IN %: [Also Known As Ratio Of Conversion Premium ] = Actual Market Price of Equity
FAVOURABLE INCOME DIFFERENTIAL PER SHARE

Coupon Interest From Debenture  Conversion Ratio  Dividend Per Share
Conversion Ratio i.e No. Of Equity Shares
PREMIUM PAY BACK PERIOD

Conversion premium per Equity share
Favourable Income Differenti al Per Share
COST OF REDEEMABLE PREFERENCE SHARES
 Maturity Value – PSC 0 

Annual Dividend   
 n 
K
 p 
Maturity Value  PSC 0
2
Note On PSCo: PSC 0 = Current Market Price [In case of existing preference share];and
P0 = Net Proceeds Where Net Proceeds = Face Value + Premium - Discount - Flotation Cost [ In case of new preference share ]
COST OF IRREDEEMABLE PREFERENCE SHARES

Annual Dividend
Kp =
PSC O
Sometimes when relevant information is not given for calculation of Kp then we simply use
Kp = Rate Of Preference Dividend
VALUE OF IRREDEEMABLE PREFERENCE SHARES
Annual Dividend
Value Of Irredeemable Preference Shares(PSCo) = Kp
VALUE OF REDEEMABLE PREFERENCE SHARES

Dividend Dividend Dividend Maturity Value
  .................. 
Value of Preference Share (PS0 ) =
(1  K P )1 (1  K P ) 2 (1  K P ) n (1  K P ) n
VALUE OFBOND UNDER REINVESTMENT CONCEPT
AADITYA JAIN
Coupon Amount x n  Face Value
B0 
In such case our equation is THE BEST SFM FACULTY
(1  YTM) n
OF INDIA
DIRTY PRICE AND CLEAN PRICE
Dirty Price = Clean Price + Accrued Interest
BASIS POINT
1 % = 100 basis points
ExamTips
CALCULATION OF BO WHEN ENTIRE PRINCIPAL & INTERESTAMOUNT IS RECEIVED AT MATURITYYEARS
Face Value(1  Coupon Rate) n

In such case our equation is : B 0 
(1  YTM) n
CALCULATION OFYTM OF HALFYEARLY

INTEREST PAYMENT BOND
 Maturity Value – Bo 
Interest per 6 months   
 n x2 
Kd Of 6month 
 Maturity Value  Bo
2
Now Kd p.a = Kd for 6 month x 2
NETASSET VALUE (NAV)
Net Asset Total Asset - Total External Liability

Symbolically : NAV = =
Number Of Units Number Of Units
Where net assets of the scheme will normally be: Total Asset - Total External Liability =
[ Market Value of Investments + Receivables + Accured Income + Other Assets ] - [ Accured Expenses + Payables + Other Liabilities ]
EXPENSE RATIO
Expenses Incurred Per Unit Opening NAV  Closing NAV
 Expense Ratio  Where Average NAV =
Average NAV 2
HOLDING PERIOD RETURN(HPR)

NAV end  NAV beginning  Dividend Received  Capital Gain Received
Holding Period Return =
NAV at the beginning
RELATIONSHIP BETWEEN RETURN OFMUTUAL FUND, RECURRING EXPENSES , INITIAL EXPENSES AND RETURN
DESIRED BY INVESTORS
Return Required By Investors   Return Of Mutual Fund  Recurring Expenses (1  Initial Expenses)
DIVIDENDYIELD METHOD OR DIVIDEND CAPITALIZATION VALUATION METHOD

Dividend Per Share (DPS)
Dividend Yield = Market Price Per Share (MPS)
Dividend Per Share (DPS)

 Market Price Per Share =
Dividend Yield
EARNINGYIELD METHOD OR INCOME OR EARNING CAPITALIZATION VALUATION METHOD

Earning Per Share (EPS)
Earning Yield = Market Price Per Share (MPS)
Earning Per Share (EPS) AADITYA JAIN

 Market Price Per Share = THEYield
Earning BEST SFM FACULTY OF INDIA
PRESENTATION OF INCOME STATEMENT TO CALCULATE MPS

Sales xxx
Less: Variable cost xxx
Contribution xxx
Less: Fixed cost xxx
ExamTips
EBIT xxx
Less: Interest xxx
EBT xxx
Less: Tax xxx
EAT xxx
Less:Preference Dividend xxx
EFE(Earning for Equity) xxx
No. of Equity Shares xxx
EPS xxx
PE Ratio xxx
MPS (EPS x PE Ratio) xxx
VALUE OF FIRM USING FUTURE MAINTAINABLE PROFITS(FMP)

Future Maintainable Profit
Value Of Business = Relevant Capitalization Rate
Calculation Of Future Maintainable Profits :

Average Past Year Profits xxxx
Add :
All Actual Expenses and Losses not likely to occur in future xxxx
All Profits likely to arise in Future xxxx
Less : All Expenses and Losses expected to arise in future (xxxx)
Less : All Profits not likely to occur in future (xxxx)
Future Maintainable Profits ( FMP ) xxxx
PRICE EARNING [P/E] RATIO VALUATION METHOD

MPS
Price Earning Ratio [ P/E Ratio ] =
EPS  MPS  P/E Ratio  EPS
Note : Total Market Value can be calculated by multiplying MPS with Number of Equity Share .
Note : If we take total earning in the above formula we will directly get Market Value .
NETASSET VALUATION METHOD

Net Assets Value = [ Total Assets - Total External Liability ]
Net Asset
Net Asset Value Per Equity Shareholder = Total Number Of Equity Share
Note : Total Asset and Total External Liability may be taken on the basis of Market Value , Liquidation Value or Book Value as the case
may be .
Note:If question is silent always use Market Value Approach.
DISCOUNTED CASH FLOW(DCF) APPROACH/FREE CASH FLOW APPROACH

It is a method of evaluating an investment by estimating future cash flows and taking into consideration the time value of money.
Note : How To Calculate Free Cash Flow :
EBDITA xxx
(-)Depreciation xxx
(-)Amortization xxx
(-)Interest xxx
EBT xxx
(-)Tax xxx
EAT xxx
+ Deprecciation xxx AADITYA JAIN
+Amortization THE xxx BEST SFM FACULTY OF INDIA
-Increase In Working Capital xxx
+Decrease In Working Capitalxxx
-Capital Expenditure xxx
Free Cash Flow xxx
ExamTips
VALUATION OF COMPANY/FIRM
Value Of Firm = Value Of Equity + Value Of Debt
CHOICE OF CORRECT DISCOUNT RATE WHILE CALCULATING VARIOUS VALUES

Use Of Discount Rate
Value Of Firm Ko
Value Of Equity Ke
Value Of Debt Kd
CALCULATION OF CAPITALEMPLOYED
Capital employed can be calculated in two ways
one way is to calculate from liabilities side and
other way is to calculate through asset side.
Let’s look at both ways
Liabilities side
Capital employed = Equity Share Capital + Preference Share Capital + Reserves – Fictitious Assets + Debentures + Long Term Loans
Assets Side
Capital Employed = Fixed assets (excluding Fictitious Assets) + Current assets – Current liabilities
SHARE EXCHANGE RATIO BASED ON EPS

EPS of Target Firm (B Ltd)
Share Exchange Ratio = EPS of Acquiring Firm(A Ltd)
SHARE EXCHANGE RATIO BASED ON MPS

MPS of Target Firm (B Ltd)
Share Exchange Ratio = MPS of Acquiring Firm (A Ltd)
SHARE EXCHANGE RATIO BASED ON BOOK VALUE PER SHARE (BVPS)

Book Value Per Share of Target Firm (B Ltd)
Share Exchange Ratio = Book Value Per Share of Acquiring Firm (A Ltd)
SHARE EXCHANGE RATIO BASED ON NETASSET VALUE PER SHARE(NAV)

Net Asset Value of Target Firm (B Ltd)
Share Exchange Ratio = Net Asset Value of Acquiring Firm (A Ltd)
TOTALNO. OFEQUITY SHARES AFTER MERGER

N A  N B  ER
EPS (A+B) WHEN SHARES ARE ISSUED

Total Earning After Merger E  E B  Synergy Gain
EPS of the Combined Firm after Merger   A
Total No. Of Equity Shares After Merger N A  N B  ER
MPS (A+B) WHEN SHARES ARE ISSUED
1st Preference :[to be used when PE A+B is given or any hint regarding this is given]
MPS of Combined Firm after Merger  EPSA  B  P/E Ratio A  B or
2nd Preference :
AADITYA JAIN
Total Market Value After Merger MVA  MVB  Synergy Gain (If Any)
MPS of Combined Firm after MergerTHE
 BEST SFM FACULTY OF  INDIA
Total No. Of Equity Shares After Merger N A  N B  ER
MARKETVALUE OFMERGED FIRM

1st Preference :MV (A+B) =  EPSA  B  P/E Ratio A  B  [N A  N B  ER]
2nd Preference :MV (A+B) = MV A + MV B + Synergy
ExamTips
EQUIVALENT EPS OF B LTD IN A NEW COMPANY
EPS ( A+B ) x ER
EQUIVALENT MPS OF B LTD IN A NEW COMPANY

MPS ( A+B ) x ER
NEW NO. OF EQUITY SHARES ISSUED TO B LTD.

N B  ER
CALCULATION OF % HOLDING IN MERGED COMPANY
For ALtd :
Total No. Of A Ltd Shares
=
Total No. Of A Ltd Shares  Total No. Of New Shares Issued To B Ltd
For BLtd :
Total No. Of New Shares Issued To B Ltd
=
Total No. Of A Ltd Shares  Total No. Of New Shares Issued To B Ltd
EPS A+B WHEN SYNERGY IS EXPRESSED IN AMOUNT

 (EarningA  EarningB  Synergy Gain) 
EPSA+B =  N A  N B x ER

 
EPS A+B WHEN SYNERGY IS EXPRESSED IN %
 (EarningA  EarningB ) (1  Synergy Gain) 
EPSA+B =  N A  N B x ER

 
MAXIMUM EXCHANGE RATIO TAKING EPS BASE-FOR ALTD

Maximum Exchange Ratio ( i.e the Exchange Ratio at which EPS of Firm’s A shareholder before and after merger will be same )
EPS Before Merger = EPS after Merger
E A  E B  Synergy
 EPSA  N  N  ER
A B
Now by solving the above equation keeping Exchange Ratio constant we can find desired Exchange Ratio.
MINIMUM EXCHANGE RATIO TAKING EPS BASE-FOR B LTD

Minimum Exchange Ratio ( i.e the Exchange ratio at which EPS of Firm ’s B shareholder before and after merger will be same )
EPS Before Merger = Equivalent EPS after Merger
 EPSB  EPSA  B  ER
E A  E B  Synergy
EPSB   ER
N A  N B  ER
IF DECISION IS BASED ON MPS [ AND IF P/E RATIO AFTER MERGER FOR A LTD IS GIVEN OR ANY HINT IN THE QUESTION
IS GIVEN REGARDING THIS ] :For A Ltd :
Maximum Exchange Ratio ( i.e the Exchange Ratio at which MPS of Firm ’s A shareholder before and after merger will be same )
MPS Before Merger = MPS After Merger
 MPSA  MPSA  B
 MPSA  P/E Ratio A  B  EPSA  B
AADITYA JAIN
 E A  E B  Synergy 
 MPSA  P/E Ratio A  B   N  N  ER 
 A B 
ExamTips
IF DECISION IS BASED ON MPS [ AND IF P/E RATIO AFTER MERGER FOR A LTD IS GIVEN OR ANY HINT IN THE
QUESTION IS GIVEN REGARDING THIS ] For B Ltd :
Minimum Exchange Ratio ( i.e the Exchange ratio at which MPS of Firm ’s B shareholder before and after merger will be same )
MPS Before Merger = Equivalent MPS after Merger
 MPS B  ER  MPS A  B
 MPS B  ER  EPSA  B  P/E Ratio A  B
 E A  E B  Synergy 
 MPS B  ER  P/E Ratio A  B   N  N  ER 
 A B 
IF DECISION IS BASED ON MPS [ AND IF P/E RATIO AFTER MERGER IS NOT GIVEN ] :For A Ltd :
Maximum Exchange Ratio ( i.e the Exchange Ratio at which MPS of Firm ’s A shareholder before and after merger will be same )
MPS Before Merger = MPS After Merger
 MPSA  MPSA  B
 AMPS  N
A  MPS  N
B B  Synergy Gain 
 MPSA   No. of Equity Shares  No. Of Equity Shares  Exchange Ratio 
 A B 
IF DECISION IS BASED ON MPS [ AND IF P/E RATIO AFTER MERGER IS NOT GIVEN ] :For B Ltd :
Minimum Exchange Ratio ( i.e the Exchange Ratio at which MPS of Firm ’s B shareholder before and after merger will be same ) :
MPS Before Merger = Equivalent MPS after Merger
 MPS B  ER  MPS A  B
 MPS  N
A A  MPS  N
B B  Synergy Gain 
 MPS B  ER   No. of Equity Shares  No. Of Equity Shares  ER 
 A B 
COMPONENTS OF MARKET PRICE PER SHARE

Market Price Per Share(MPS) =Earning Per Share (EPS)  Price Earning Ratio (PE Ratio)
Earning For Equity Shareholder Market Price Per Share
= No. of Equity Share  Earnings Per Share
Market Price Per Share

= [Return on Equity(ROE)  Book Value / Intrinsic Value Per Share ]  Earnings Per Share
Earning For Equity Shareholder Equity Shareholder' s Fund Market Price Per Share
= Equity Shareholder' s Fund  No. of Equity Shares  Earnings Per Share
s
Where Equity Shareholder's Fund = Equity Share Capital + Reserves - P/L account ( Dr.)
EPS A+B WHEN CASH IS PAID OUT OF BORROWED MONEY

 (EarningA  EarningB  Borrowed Amount  Interest Rate  (1  Tax Rate) 
EPSA+B =  NA

 
EPS A+B WHEN CASH IS PAID OUT OF BUSINESS MONEY
EPSA+B AADITYA JAIN
THE
 (EarningA  EarningB  Cash Paid BESTy Cost
 Opportunit SFM FACULTY
Of Interest  (1 - tax)  OF INDIA
= NA

 
MARKETVALUEAFTER MERGER WHEN GROWTH RATE OF B LTD UNDER NEW MANAGEMENT INCREASES
Market Value After Merger = MPS A x No. Of Equity Share A + New MPS B Taking new growth rate x No. Of Equity Share B + Synergy
to be taken as zero
ExamTips
NPV OF A LTD UNDER MERGER
PV Of Cash Flows Received By A Ltd From B Ltd xxx
Less: Cost of Acquisition Paid By A Ltd To B Ltd xxx
NPV Of A Ltd if B Ltd is acquired xxx
Decision:If NPV is positive, Altd should takeover Bltd.
COST OF MERGER-WHEN CASH IS PAID-FOR A LTD

Cost = Cash Paid - Market Value Of B received
COST OF MERGER-WHEN SHARES ARE ISSUED-FOR A LTD

Cost =Value of shares given – Value Of B Received =   Combined Value Of A & B –Value Of B received
Where  represents the % holding of B Ltd. in merged firm
SYNERGY GAIN-BASED ON EARNINGS

Merger Gain or Synergy Based On Earnings = Total Combined Earning Of Merged Firm -[Earning Of A + Earning Of B]
SYNERGY GAIN-BASED ON MARKETVALUES

Merger Gain or Synergy Based On Market Value
= Total Combined Market Value Of Merged Firm -[Market Value Of A + Market Value Of B]
EFFECT OF CASH TAKEOVER IN EARNINGSAND MARKET VALUE

Total Earning After Merger
= Earning A + Earning B - Opportunity/Borrowing Cost Of Cash Paid Adjusted For Tax
Total Market Value After Merger = Market Value A + Market Value B - Cash Paid
GROSS NPA(%)
Gross NPA
GNPA Ratio   100
Gross Advance or Deposit Given By Bank
CAR [CAPITALADEQUACY RATIO] OR CRWAR [ CAPITAL TO RISK WEIGHTED ASSET RATIO]

Total Capital
CAR or CRWAR or Total Capital To Risk Weight Asset Ratio = Risky Weighted Assets
CALCULATION OF SWAP RATIO IN CASE OF NEGATIVE FACTOR LIKE GROSS NPA

Gross NPA Of A Ltd.
Swap Ratio 
Gross NPA Of B Ltd.
CALCULATION OF RETURN OFA SECURITY OR ASSET
Price At The End  Price At The Beginning  Any Income Distribution
Holding Period Return  Price At The Beginning
STANDARD DEVIATION ( σ ) BASED ON PAST DATA
(Given Return  Average Return)2

Standard Deviation ( σ ) =
n
STANDARD DEVIATION ( σ ) BASED ON PROBABILITY
Standard Deviation (  ) =  probability  (Given Return  Expected Return)2

AADITYA JAIN
VARIANCE
Variance = Standard Deviation 2 = σ 2
Decision:Higher the variance,higher the risk.
COEFFICIENT OF VARIATION (CV ):-PAST DATA
Coefficient Of Variation measures Risk Per Unit Of Return.
ExamTips
Standard Deviation
CV= Average Return
Decision:Higher the CV , higher the risk.
COEFFICIENT OF VARIATION (CV ) BASED ON PROBABILITY

Standard Deviation
CV = Expected Return
Decision:Higher the CV , higher the risk.
RETURN OF PORTFOLIO-BASED ON PAST DATA

The Return of the portfolio is the weighted average return of individual security .
Return Of Portfolio = A's Average Return  Weight A + B's Average Return  Weight B
RETURN OF PORTFOLIO ON THE BASIS OF PROBABILITY

Return Of Portfolio = A's Expected Return  Weight A + B's Expected Return  Weight B
Note : Sum of Weights used in Portfolio for different security will always be equal to 1 .
STANDARD DEVIATION OF THE PORTFOLIO CONSISTING OF TWO SECURITY
Standard Deviation [σ1 2 ]  σ12 w12  σ 2 2 w 2 2  2 σ1 w1 σ 2 w 2 r 1,2
Where , σ1 2 = Standard Deviation of Portfolio consisting of Security 1 & 2

σ1  Standard Deviation Of Security 1 ; σ 2  Standard Deviation Of Security 2 ;
W1  Weight Of Security 1 ; W2  Weight Of Security 2 ; r 1,2 Coefficien t Of Correlation Between Security 1 and Security 2
COEFFICIENT OF CORRELATION (r)

Covariance (A , B )
Coefficient of Correlation between A & B : ( rA , B )  σ A  σB
COVARIANCE -BASED ON PAST DATA

Given Return A  Average Return A   Given Return B  Average Return B   d A  d B 
Covariance (A , B) = 
n n
COVARIANCE BASED ON PROBABILITY
Covariance (A , B)   probability  Given Return A  Expected Return A Given Return B  Expected Return B 
WHEN RISK REDUCTION IS ACHIEVED BY BUILDINGA PORTFOLIO/CONCEPT OF RISK REDUCTION

Risk Reduction is achieved when Portfolio Standard Deviation is less than Weighted Average Standard Deviation Of Individual
Security.
MEANING OF r=+1
It is a Perfect Positive Correlated Portfolio Portfolio Risk will be Maximum
Standard Deviation Of Portfolio will become (σ A  B )  σ A  WA  σ B  WB
MEANING OF r=-1
It is a Perfect Negative Correlated Portfolio Portfolio Risk will be minimum
AADITYA JAIN
Standard Deviation Of Portfolio will become (σ A  B )  σ A  WA  σ B  WB
THE BEST SFM FACULTY
MEANING OF r=0 OF INDIA
It is a No Correlated Portfolio .Portfolio Risk will be between minimum and maximum range
Standard Deviation Of Portfolio will become = (σ A  B )  σ 2 A  W 2 A  σ 2 B  W 2 B

RANGE OF ‘R’OR COEFFICIENT OF CORRELATION
Range of r is between -1 to +1
ExamTips
DECISION ON THE BASIS OFVALUE OF ‘R’
Higher the r, higher the risk.As r increases, risk also increases When r = -1 : Minimum Risk When r =+1 :Maximum Risk
Overall Decision : Lower the Standard Deviation , Coefficient Of Variation , Variance or Range Lower will be the Risk Of Security .
STANDARD DEVIATION OF PORTFOLIO CONSISTING OF

THREE SECURITIES
 σ ABC  σ 2 w 2  σ 2B w 2B  σ 2 w 2  2w A σ A w Bσ B rAB  2w B w Cσ Bσ C rBC 

A A C C
When r = +1 we can use short cut formula : σ ABC  σ A w A  σ B w B  σ C w C
CAPITALASSET PRICING MODEL (CAPM) BASED RETURN

Symbolically : Expected Return /Required Return /Equilibrium Return /Desired Return =
Beta Security
Rf 
Beta Market
(Rm – Rf)  = Rf  Beta Security (Rm – Rf) 
CAPITALASSET PRICING MODEL (CAPM) BASED DECISION OR UNDERVALUED /OVERVALUED CONCEPT

Case Valuation Decision
If CAPM Return > Given Return Overvalued or Overpriced Sell
If CAPM Return < Given Return Undervalued or Underpriced Buy
If CAPM Return = Given Return Correctlyvalued or Correctly priced Hold
BETA OFA SECURITY BASED ON % RETURN CHANGES

Beta is the degree of the responsiveness of the security's return with the market return .
Change in Security Return
Hence Beta may also be defined by using following relation : Beta  Change in Market Return
This equation is normally applicable when two return data is given.
CALCULATION OF BETA USING COVARIANCE FORMULA

Beta is a ratio of " Covariance Of Security with the Market " and "Variance Of Market"
Covariance between Security and Market Covariance (s, m)

Beta of an Asset or Security = =
Variance of the market σ m2
BETA OFA SECURITY USING CORRELATION

rs, m  σ s
 Beta Of Security 
σm
ARBITRAGE PRICING THEORY [ STEPHEN ROSS'S APT MODEL ] /MULTI FACTOR MODEL
Symbolically : Overall Return in case of APT will be = Risk Free Return + (Beta x Risk Premium ) Of Each Factor
= Risk Free Return + { Beta Inflation  Inflation Differential or Premium }+ { Beta GNP  GNP Differential or Premium} ....+ and so on
Where , Differential or Premium = [ Actual Value - Expected/Estimated Value ]
PORTFOLIO EVALUATION TECHNIQUE-SHARPE RATIO

It indicate the amount of return earned per unit of risk. It is also known as Reward to Risk Ratio or Reward to Variability Ratio .
AADITYA JAIN
Return Of Security  Return Of Risk Free Investment
Symbolically :Sharpe Ratio = THE BEST SFM FACULTY OF INDIA
Standard Deviation Of Security
Decision : Higher the ratio, Better the performance
TREYNOR RATIO
This ratio measures the return earned per unit of systematic risk. It is also known as the Reward to Volatility Ratio.
ExamTips
Return Of Security  Return Of Risk Free Investment

Symbolically : Treynor Ratio = Beta Of Security
Decision : Higher the ratio, Better the performance
JENSEN’S ALPHA / JENSEN'S INDEX

Symbolically : Jensen’s Alpha = Actual or Given or Expected or Average Return - CAPM Return
where, CAPM Return = Rf + Beta ( Rm - Rf )
Decision : If Alpha is positive it shows that the portfolio has performed better and it has out performed the market. If Alpha is negative,
it means that the portfolio has underperformed as compared to the market. If Alpha is zero, it indicates that the portfolio has just
performed what it is expected to.
STANDARD DEVIATION OF PORTFOLIO CONSISTING OF FOUR SECURITIES
σ 2 w 2  σ 2B w 2B  σ 2 w 2  σ 2D w 2D 
A A C C
2w A σ A w B σ B r A B  2w A w C σ A σ C rAC
σ ABCD 
  2w B w C σ C σ B rBC  2w C w D σ C σ D rCD 
2w D w A σ D σ A rDA  2w B w D σ B σ D rBD
When r = +1 we can use short cut formula σ ABC  σ A w A  σ B w B  σ C w c  σ D w D
STANDARD DEVIATION OF PORTFOLIO CONSISTING RISK FREE & RISKY SECURITY

(σ A  B )  σ A  WA Where A is risky security & B is risk free security
STANDARD DEVIATION OF PORTFOLIO CONSISTING RISK FREE & RISKY SECURITY

(σ A  B )  σ A  WA Where A is risky security & B is risk free security
BETA OFA PORTFOLIO

Beta of a portfolio is the weighted average beta of individual securities .
Symbolically : Beta Of Portfolio = Beta Of Security A  Weight Of A  Beta Of Security B  Weight Of B = β A WA  β B WB
SECURITY MARKET LINE (SML)

A Graphical representation of CAPM is known as Security Market Line .
Expected Return under SML is calculated by using following equation :
Beta Security
Rf 
Beta Market
(Rm – Rf)  = Rf  Beta Security (Rm – Rf) 
Note:Beta of market assumed to be 1.

Decision :
If a security lie on SML :Efficient Security Correctly Priced Hold Security giving Optimum Return as expected
If a security lie below SML :Inefficient Security Over Priced Sold Security giving Low Return than expected
If a security lie above SML :Inefficient Security Under Priced Buy Security giving High Return than expected
CAPITALMARKET LINE (CML)

Capital Market Line shows the relationship between Return & Standard Deviation of security.
Capital Market Line takes into account Total Risk .
AADITYA JAIN
σ 
Return under CML is calculated byTHE BEST equation
using following R f   S   ROF
SFM :FACULTY f
m  RINDIA
 σm 
Decision : Same as SML
CHARACTERISTICS LINE (CL)

The Characteristic Line shows the relationship between the Return Of an Investment in Security and Return Of Market Portfolio.
ExamTips
Equation Of Characteristics Line : Y = a  β  X , Where

Y = Average or Expected Return for the Security ;X = Average or Expected Return of the Market Portfolio ; β = Beta of Security
a = Intercept or alpha which can be calculated as Y  β  X
SLOPE OF CHARACTERISTICS LINE (CL)

Beta of a security is a slope of Characteristics Line .
SLOPE OF SML
Rm  Rf
Slope Of SML may be obtained as follows :  Rm  Rf
Bm
SLOPE OF CML
Rm  Rf
Slope Of CML may be obtained as follows : σm
COVARIANCE FORMULA USING CORRELATION

Covariance (A , B )  rA, B  σ A  σ B
CALCULATION OF OPTIMUM WEIGHTS TO MINIMIZE PORTFOLIO RISK WHEN WEIGHTS ARE MISSING
Under this concept we will try to find out that " What percentage in each of the security consisting in the portfolio would result into
lowest possible risk " . Hence if we are asked to calculate optimum weights which will reduce our portfolio risk then we will use following
formula :
σ B2  r A , B  σ A  σ B σ B2  Covariance (A, B)
WA  
σ A 2  σ B2  2  r A , B  σ A  σ B σ A 2  σ B2  2  Covariance (A, B)
and WB  1  WA (Since WA  WB  1 )
SHORT CUT FORMULA FOR OPTIMUM WEIGHTS WHEN r  1

When r = -1 then we can also use the following formula for finding Optimum Weights
σY σX
WX  ; Wy  or 1  WX (Since WX  WY  1 )
σ X  σY σX  σ Y
Note : If we find the Standard Deviation ( risk ) from this optimum weights when r = -1 then portfolio risk will be zero .
COVARIANCE OFA SECURITY WITH THE SAME SECURITY

Covariance(A, A)  Variance Of A
Note: Covariance with oneself is variance.
CORRELATION OFA SECURITY WITH SAME SECURITY (RA,B)

rA,B = 1
COVARIANCE MATRIX
A B C
A cov(A,A) cov(A,B) cov(A,C)
B cov(A,B) cov(B,B) cov(B,C)
C cov(A,C) cov(C,B) cov(C,C)
AADITYA
NEW FORMULA JAINUSING BETA
OF COVARIANCE
Covariance between any 2 stocks = βTHE BEST
2
1  β2  σ m
SFM FACULTY OF INDIA
RISK RETURN RATIO (TRADE OFF) OFMARKET

ExamTips
Rm  Rf
Risk Return Trade Off Of Market = σm
HOW TO CALCULATE SYSTEMATIC RISK AND UNSYSTEMATIC RISK / SHARPE INDEX MODEL
FOR A SECURITY :Total Risk = σ s 2 ;
Systematic Risk Of a Security = σ m 2β s 2 ;Unsystematic Risk Of a Security = Total Risk - Systematic Risk = σ s 2 - σ m 2β s 2
FOR A PORTFOLIO: Total Risk = σ P 2
Systematic Risk Of a Portfolio= σ m 2β P 2 ;
n
2 2
Unsystematic Risk Of a Portfolio = Total Risk - Systematic Risk = σ P 2 - σ m 2β P 2 or  σ USR w
i 1
CALCULATION OFSYSTEMATIC & UNSYSTEMATIC RISK USING COEFFICIENT OFDETERMINATION

Coefficient Of Determination = (coefficie nt of correlation)2  (r 2 )
Use of Coefficient of Determination in calculating Systematic Risk & Unsystematic Risk
Explained by the index (Systematic Risk)= Variance of Security Return x Co-efficient of Determination of Security or
Variance of Security Return x r 2 or σ 2s  r 2 s, m

Not explained by the index(Unsystematic Risk) = Variance of Security Return  (1- Co-efficient of Determination of Security)
2  2 
or Variance of Security Return  (1 – r 2 ) or or σ s  1 - r s, m 
 
CONVERTING DIRECT QUOTE INTO INDIRECT QUOTEAND VICE-VERSA-WHEN BID & ASK RATE ARE SAME
Direct Quotes can be converted into Indirect Quotes by taking reciprocals of each other, which can be mathematically expressed as
1 1
follows: Direct Quote = or Indirect Quote =
Indirect Quote Direct Quote
1
For Example : 1 DM = Rs. 20 is a direct quote for India. 1 Re. = DM is indirect quote for India
20
CONVERTING DIRECT QUOTE INTO INDIRECT QUOTE AND VICE-VERSA -WHEN BID ANDASK RATE ARE DIFFERENT
Direct Quotes can be converted into Indirect Quotes by taking reciprocals of each other and then switching the position.
For Example : Direct Quote wih reference to India : 1 $ = Rs. 46.10 / 46.20.
1 1
Indirect Quote with reference to India : Re 1  $ $ or Re 1 = $ .02165 - $ .02170
46.20 46.10
CALCULATION OF CONTRIBUTION TO SALES RATIO UNDER FOREX

Contributi on
Contribution to Sales Ratio =  100
Sale
Decision-Higher the C/S Ratio better the situation
CONTRIBUTION
AADITYA JAIN
Contribution is the selling price minus the variable cost.
EXCHANGE MARGIN
Exchange Margin is the extra amount or percentage charged by the bank over and above the rate quoted by bank .It represents
commission , transaction related expenses etc .
In case of Buying Rate Quoted by bank : Deduct Exchange Margin : i.e Actual Buying Rate =Bid Rate( 1-Exchange Margin )
In case of Selling Rate Quoted by bank : Add Exchange Margin : i.e Actual Selling Rate = Ask Rate ( 1+ Exchange Margin )
S
ExamTips
PREMIUM AND DISCOUNT
How to Calculate Premium or Discount : Rate of Premium or Discount of Left Hand Currency is given by :
Forward Rate  Spot Rate 12
 100
Spot Rate Forward Period
PURCHASE PRICE PARITY THEORY [PPPT]-CALCULATION OF SPOT RATE

A [Current Price in India ]
Spot Rate (Rs. / $ )=
B [ Current Price in USA ]
PURCHASE PRICE PARITY THEORY [PPPT ]-CALCULATION OF FORWARD RATE-USING INFLATION

 1  Rupee Inflation 
Symbolically :As per PPP Theory we have : Forward Rate (Rs/$)     Spot Rate (Rs./$) or
 1  Dollar Inflation 
Forward Rate (Rs/$)  1  Rupee Inflation 

 
Spot Rate (Rs./$)  1  Dollar Inflation 
DETERMINATION OF PREMIUM & DISCOUNT USING PPPT

Higher Rate of Inflation in one country (as compared to the other country) results in discount of currency of that country and vice-
versa.
INTEREST RATE PARITY THEORY (IRPT)
Meaning :IRPT is based on the concept that investment opportunity in any two given country will always be same.
Forward Rate (Rs/$) 1  Rupee Interest Rate
Symbolically : 
Spot Rate (Rs./$) 1  Dollar Interest Rate
DETERMINATION OF PREMIUM & DISCOUNT USING IRPT

Higher Rate of Interest in one country (as compared to the other country) results in discount of currency of that country and vice-
versa.
SPREAD
The difference between Ask and Bid Rates is called the Spread , representing the profit margin of the dealer .
Spread = Ask Rate - Bid Rate
CALCULATION OF NET EXPOSURE USING FORWARD RATE AND SPOT RATE

Net exposure we mean advantage of using Forward Contract over Spot Contract .
Net exposure = Net Cash Flow x ( Forward Rate - Spot Rate ) = Net Cash Flow x Swap Points
Decision:A positive Net Exposure indicates benefit of Forward Rate over Spot Rate.
INTERNATIONALFISHER EFFECT(IFE)
It analyses the relationship between the Interest Rates and the Inflation .
As per IFE we have(1+Money Interest Rate )=(1+Real Interest Rate)(1+Inflation Rate )
INTEREST RATE DIFFERENTIAL-NOARBITRAGE

When Difference in Interest Rates Between The Two Countries is equal to Premium Or Discount - No Arbitrage Is Possible
Interest Rate Differential is just another name of premium or discount of one currency in relation to another currency i.e
FR[Rs/$] - SR[Rs/$] 12
  100  Interest Rate Of Rupee  Interest Rate Of Dollar
SR[Rs/$] Forward Period
AADITYA JAIN
GAIN OR LOSS UNDER FUTURE CONTRACT-LONG POSITION
Position THE BEST ActualSFMPrice
FACULTY OF INDIA
On ExpirationProfit/Loss
Long Increase Profit
Long Decrease Loss
GAIN OR LOSS UNDER FUTURE CONTRACT-SHORT POSITION

Short Increase Loss
Short Decrease Profit
ExamTips
HOW SETTLEMENT IS DONE UNDER LONG POSITION
Long Position is settled by taking Short Position at the time of settlement
HOW SETTLEMENT IS DONE UNDER SHORT POSITION

Short Position is settled by taking Long position at the time of settlement
POSITIONS UNDER STOCK MARKET

Long Position : If a person buys or holds an asset , he is said to be in a Long Position .
Short Position : If a person sells an asset , he is said to be in a Short Position .
INITIAL MARGIN
Initial Margin deposited is not an expense it is just like security deposit .
Sometimes when initial margin is not given in question it can be calculated by using following equation:
Initial Margin = Daily Absolute Changes + 3 x Standard Deviation
MARK TO MARKET MARGIN

It is like a profit and loss account.
WHEN INTEREST RATE IS COMPOUNDED CONTINUOUSLY OR INFINITY

 Future Value  Present Value  e r t
Future Value
 Present Value   Future Value  e - r  t
e r  t
PRESENT VALUE WHEN INTEREST RATE IS DISCOUNTED CONTINIOUSLY

Future Value
Present Value   Future Value  e - r  t
e r t
FAIR FUTURE PRICE OF SECURITIES
 Basic Principle While Calculating Fair Future Price :
1.Cost:
If Given In Rs.: Add in CMP ; If Given In % :Add in rate
2.Dividend:
If Given In Rs.: Deduct in CMP ; If Given In % :Deduct in rate
HOWTO CALCULATE ARBITRAGE PROFIT ? WHEN-ACTUAL FUTURE VALUE > FAIR FUTURE VALUE
Case Valuation Borrow/Invest Cash Future
Market Market
Actual Future Value > Fair Future Value Overvalued Borrow Buy Sell
PRINCIPLE OF CONVERGENCE
The process by which the futures price and the cash price of an underlying asset approach one another as delivery date nears. The
futures and cash prices should be equal on the delivery date.
HOWTO CALCULATEARBITRAGE PROFIT ? WHEN-ACTUAL FUTURE VALUE < FAIR FUTURE VALUE
Case Valuation Borrow/Invest Cash Future
Market Market
Actual Future Value < Fair Future Value Undervalued Invest Sell* Buy
* here we are assuming that arbitrageur holds one share in cash market.
AADITYA
POSITION TO BE TAKENJAIN FOR HEDGING
If you are Short on any Security THE BEST SFMgoFACULTY
You should OF INDIA
Long in Index [Sensex or Nifty]
If you are Long on any Security You should go Short in Index [Sensex or Nifty]
VALUE OFINDEX TO BE HEDGED FOR COMPLETE HEDGING

The extent or value of hedging ( hedge ratio ) is determined by the beta of a security and value of current portfolio .
Extent Of Hedging or Total Value to be hedged or Value of Perfect Hedge = Existing Beta Of The Stock  Value Of Transaction or Value
Of Exposure or Current Value Of Portfolio which requires hedging
ExamTips
VALUE OF HEDGING FOR INCREASING & REDUCING BETATO A DESIRED LEVEL (ASSUMING LONG POSITION)
When Existing beta > Desired beta
Objective:Reducing Risk
Position To Be Taken:Take Short Position
Amount Of hedging Required = Value of Existing Portfolio x (Existing Beta - Desired Beta)
When Existing beta < Desired beta
Objective:Increasing Risk
Position To Be Taken:Take Long Position
Amount Of hedging Required = Value of Existing Portfolio x (Desired Beta - Existing Beta )
BETA OF CASH & CASH EQUIVALENT

Beta of Cash & Cash equivalent is always assumed to be zero.
.DETERMINATION OFNUMBER OFFUTURE CONTRACTS TO BE TAKEN

The number of futures contract to be taken for increasing and reducing beta to a desired level is given by the following formula :
Value Of Total Index Future Position
=
Value Of One Index Future Contract
HEDGE RATIO UNDER FUTURE CONTRACT
σs
Hedge Ratio i.e Existing Beta for complete hedge purpose= rs.f  σ
f
σ s =Standard Deviation of the Spot Price ; σ f = Standard Deviation of the Future Price; rs, f = Correlation Coefficient between the two
OPTION- AN UNDERSTANDING
In Forward Contract : Both parties are obliged to perform
In Future Contract : Both the parties are obliged to perform
In Option Contract : Only one party is obliged to perform
TYPES OF OPTION-CALL & PUT

(i) Call Option Contract (ii) Put Options Contract
PARTIES OF OPTION CONTRACT

(i) Call Option (i) Call Writer / Call Seller (ii) Call Holder/Call Buyer
(ii)Put Option (i) Put Writer / Put Seller (ii) Put Holder/Put Buyer
DIFFERENCE BETWEEN CALLBUYERAND CALLSELLER

CALLBUYER CALL SELLER
Pay Premium Receive Premium
Purchase Right Sell Right
Buy Share Sell Share
DIFFERENCE BETWEEN PUT BUYERAND PUT SELLER

PUT BUYER PUT SELLER
Pay Premium Receive Premium
Purchase Right Sell Right
Sell Share Buy Share
PAY OFF/PROFIT & LOSS OFA CALL BUYER

Pay off means Profit and Loss.
Call Option : AADITYA JAIN
Profit : When Cash Market Price As On Expiry
THE BEST SFM > Strike PriceFACULTY OF INDIA
In such case Call Buyer will exercise the Option.
Net Profit = Cash Market Price As On Expiry - Strike Price - Option Premium
Loss : When Cash Market Price As On Expiry < Strike Price
In such case Call Buyer will not exercise the option .
His loss is limited to the amount of Call Premium. i.e Loss = Amount Of Premium Paid
ExamTips
PAY OFF/PROFIT & LOSS OFA PUT BUYER
Pay off means Profit and Loss.
Put Option :
Profit : When Cash Market Price As On Expiry < Strike Price
In such case Put Buyer will exercise the option .
Net Profit = Strike Price - Cash Market Price as on expiry - Option Premium
Loss: When Cash Market Price As On Expiry > Strike Price
In such case Put Buyer will not exercise the Option.
His Loss will be limited to the amount of premium.
BREAK EVEN PRICE OF CALL OPTION

Breakeven price is the market price at which the option parties neither makes a profit nor incur any losses.
Break-Even Market Price for Buyer and Seller of Call Option :
Exercise Price + Option Premium
BREAK EVEN PRICE OF PUT OPTION
Breakeven price is the market price at which the option parties neither makes a profit nor incur any losses.
Break-Even Market Price for Buyer and Seller of Put Option :
Exercise Price  Option Premium
POINT OF MAXIMUM PROFIT & LOSS- FOR CALL BUYER & SELLER
Call Buyer maximum loss--the amount of premium paid
Call Seller maximum profit will be equal to the amount of premium received
Call Buyer maximum profit will be unlimited
Call Seller maximum loss will be unlimited
POINT OF MAXIMUM PROFIT & LOSS- FOR PUT BUYER & SELLER
Put Buyer maximum loss is the amount of premium paid
Put Seller maximum profit will be equal to the amount of premium received
Put Buyer maximum profit will be equal to Strike Price - Premium Paid
Put Seller maximum loss will be Strike Price - Premium Received
TYPES OF RIGHT
Right To Buy Shares-Call Buyer ; Right To Sell Shares-Put Buyer
IN / OUT /AT THE MONEY OPTION-FOR CALL BUYER

Market Scenario IN/OUT/AT
Cash Market Price as on expiry > Strike Price In the Money
Cash Market Price as on expiry < Strike Price Out Of The Money
Cash Market Price as on expiry = Strike Price At The Money
Note : The above position is reversed for the Writer of the Option .
IN / OUT /AT THE MONEY OPTION-FOR PUT BUYER

Market Scenario IN/OUT/AT
Cash Market Price as on expiry > Strike Price Out Of The Money
Cash Market Price as on expiry < Strike Price In the Money
Cash Market Price as on expiry = Strike Price At The Money
Note : The above position is reversed for the Writer of the Option .
FAIR VALUE/PREMIUM/PRICE OFCALL OPTION AS ON EXPIRY

Value(Premium) of Call Option at expiration
= Maximum of ( Cash Market Price As On Expiry - Strike Price , 0)
AADITYA JAIN
THE
FAIR BEST SFM FACULTY
VALUE/PREMIUM/PRICE OFASINDIA
OFPUT OPTION ON EXPIRY
Value(Premium) of Put Option at expiration
= Maximum of ( Strike Price - Cash Market Price As On Expiry , 0)
FAIR VALUE OF CALL OPTION BEFORE EXPIRY DATE MINIMUM THEORETICAL PRICE OF CALL OPTION
Theoretical Minimum Value of Call Option : = Spot Price – Present Value of Strike Price =Spot Price – Strike Price  e–rt
ExamTips
FAIR VALUE OF PUT OPTION BEFORE EXPIRY DATE : MINIMUM THEORETICAL PRICE OF PUT OPTION
Theoretical Minimum Value of Put Option:
= Present Value of Strike Price– Current Market Price =Strike Price  e–rt –Current Market Price
INTRINSIC VALUE AND TIME VALUE OF OPTION-CALL

Option Premium is the component of two parts : Intrinsic Value + Time Value of Money
Intrinsic Value of Call Option= Maximum of (0,Current Market Price As On Today-Exercise Price);
Time Value of Option = Option Premium - Intrinsic Value
INTRINSIC VALUE AND TIME VALUE OF OPTION-PUT

Intrinsic Value of Put Option=Maximum of (0,Exercise Price-Current Market Price).
Time Value of Option = Option Premium - Intrinsic Value
STRADDLES
Straddle can be of two types:
1.Long Straddle :Buying a Call and a Put with the same strike price and the same exipry date. In Long straddle the investor will have
to pay premium on the call as well as on put option contract.
2.Short Straddle :Selling a Call and a Put with the same strike price and the same exipry date.In Short straddle the investor will
receive premium on the call as well as on put option contract.
If question is silent always assume Long Straddle.
RISK NEUTRAL METHOD-FOR CALL

C1  p  C 2  (1  p)
Value/Premium/Price Of Call As On Today = 
(1  r)
HOW TO CALCULATE PROBABILITY

Spot Price (1  Interest Rate)  Lower Price
Alt 1 : p 
Higher Price - Lower Price
r = rate of interest adjusted as per option period . For example if annual rate of interest is 10 % and Option period is 3 months then we will
take .025 in the above formula .
CALCULATION OFOPTION PREMIUM FOR CALL UNDER BIONOMIALMODEL-HEDGE RATIO TECHNIQUE

Option Premium =   Current Market Price - Amount Of Borrowing Where,
Value Of Call On Expiry At High Price  Value Of Call On Expiry At Low Price C1 – C 2
 / Hedge Ratio/Option Delta = High Price  Low Price
= S –S
1 2
1
Amount Of Borrowings : B = 1  r (Δ S2 – C 2 )
CALCULATION OFAMOUNT OF BORROWING UNDER HEDGE RATIO TECHNIQUE

1 1
Amount Of Borrowings : B = (Δ S2 – C 2 ) or (Δ S1 – C1)
1 r 1 r
Where r = rate of interest adjusted for periods for example if rate of interest is 10% pa and we are asked to calculate 6 month option
premium,then we have to adjust 10% pa for 6 month i.e we will take 5%.
HEDGE RATIO OR DELTA FOR CALL

Change in Option Premium C  C2
S Delta Δ   1AADITYA JAIN
Change in Price of Underlying Asset S1  S2
THE
Note : Delta of a Call Option is always BEST
positive SFM
and Delta of a PutFACULTY
Option is alwaysOF INDIA
negative
DELTA OF PUT OPTION

Value Of Put On Expiry At High Price  Value Of Put On Expiry At Low Price C1 – C 2
Delta = High Price  Low Price
= S –S
1 2
Note:It will always be negative.
ExamTips
OPTIONS GREEKS
GAMMA
 Gamma ( Sensitivity to Change in Delta ) :It is a measure of the rate of change of the delta with respect to the price of the underlying
asset .
Change in Delta
It is calculated as : Gamma  Change in Price of Underlying Asset
VEGA
Vega( Sensitivity to Change in Volatility of Asset Price ):It is a measure of rate of change in option price with respect to the percentage
change in volatility.
Change in Option Premium
It is calculated as : Vega  Change in Volatility of Price
THETA
Theta ( Sensitivity to Change in Time to Expiry ) : It is the rate of change in value of the option with respect to time to maturity.
It is calculated as Theta  Change in Time to Expiry
RHO
Rho ( Sensitivity to Change in Interest Rate ) : It is the rate of change in option price with respect to change in interest rate .
It is calculated as : Rho  Change in Rate of Interest
PUT CALL PARITY THEORY (PCPT)

Symbolically : As per PCPT we have :
OP Of Call As On Today + Present Value of Strike Price = OP of Put As On Today + Current Market Price
BLACK & SCHOLES MODEL-FOR CALL

Value or Premium Of Call Option = Spot Price N(d1) – Exercise Price e–rt N(d2)
HOW TO CALCULATE D1 & D2

 Current Market Price 
ln   [r  .50σ 2 ]  t
 Exercise Price  ; d2 = d 1 – σ t
d2 
σ t
σ = Standard Deviation ;t = remaining life to expiration of the option in terms of year for example for a call option of 6 months t = .5 , for
73
a call option of 73 days t = ;r = continuous compounded risk free annual rate of return ;ln = Natural Log
365
BLACK & SCHOLES MODEL-WHEN DIVIDENDAMOUNT IS GIVEN
As per BSM Model : Value of Call Option = Adjusted Current Price N(d1) – Exercise Price e–r x t N(d2)
 Adjusted Current Market Price  2
ln 
Exercise Price   [r  .50σ ]  t
Where d1    ;d2 = d1 – σ t
σ t
Where Adjusted Current Market Price = Current Market Price - Present Value Of Dividend Income
PARTIES TO LEASE AGREEMENT

There are two parties under any lease agreement :
(i) Lessor : Owner of the asset is known as Lessor . AADITYA JAIN
(ii) Lessee : The party who uses the THE
asset is known
BESTas Lessee
SFM. FACULTY OF INDIA
TREATMENT OF DEPRECIATION
Depreciation can be calculated in the following manner :
(i) Straight Line Method (SLM)
(ii) Written Down Value (WDV)
Depreciation is charged by the owner of the asset.
ExamTips
Under Lease Agreement it is the lessor who claims the depreciation and
Under Loan Agreement it is charged by the Borrower.
Depreciation is not an item of Cash Outflow,hence it should not be considered for our analysis.
However Tax Saving on depreciation is an item of inflow and hence must be recognized .
Tax Saving On Depreciation = Amount Of Depreciation x Tax Rate
TREATMENT OF SALVAGE VALUE-WDV -IN CASE OF PROFIT

Adjusted Salvage Value = Salvage Value - Profit On Sale x Tax Rate
TREATMENT OF SALVAGE VALUE-WDV -IN CASE OF LOSS

Adjusted Salvage Value = Salvage Value + Loss On Sale x Tax Rate
TREATMENT OF SALVAGE VALUE-SLM

Salvage Value is not adjusted for tax under SLM unless otherwise stated.
TREATMENT OFTAXATION
All cash inflows and outflows which are a part of Profit and Loss account should be taken after tax.
TREATMENT OFTAXATION FOR ITEMS ARISINGAT THE BEGINNING OF EACH YEAR :

Tax Savings On Items Arising At the Beginning of each year can be taken
Alt 1: Either at the end of each year [ Normally preferred in case of Leasing Chapter]
Alt 2:At the beginning of each year
PARTIES UNDER LOAN AGREEMENT

There are two parties under loan agreement
1.Borrower :
Borrower will take loan
Borrower will be the user as well as the owner of the assets
Borrower will be entitled to Charge deptreciation and will receive Salvage value
2.Bank
Bank will give loan
Bank will be neither be a user or nor the owner of the assets
Bank will be not Charge depreciation and will not receive Salvage value
LESSEE VS BORROWER
Calculate Present Value Of Outflow under both the option separately by using the discount rate and choose such option which
involves least outflow.
LESSEE BORROWER
No Depreciation Charge Charge Depreciation
User User & Owner
Not Entitled To Salvage Value Entitled To Salvage Value
Pay Lease Rent No Lease Rent Is Paid
No Principal Repayment Principal Repayment
No Payment Of Interest Interest Payment
EVALUATION FOR LESSEE

Lessee should choose such option which will minimize its Outflow and maximize its Inflow . He should generally undertake the
following steps for taking decision :
Step 1 : He should first evaluate its inflow and outflow under both the option given in question
Major Outflow Under Leasing Option :
(i) Lease Rent Paid Net Of Tax
Major Inflow Under Leasing Option : AADITYA JAIN
No major inflow for lessee THE BEST SFM FACULTY OF INDIA
There may be other inflow and outflow which, if given in question,must be also taken into account .
Step 2 : Discount Rate : Kd = Interest Rate ( 1- Tax)
Step 3 : Calculate Present Value Of Cash Outflow(PVCO) by using the discount rate
ExamTips
EVALUATION FOR BORROWER
Borrower should choose such option which will minimize its Outflow and maximize its Inflow.He should generally undertake the
following steps for taking decision :
Step 1 : He should first evaluate its inflow and outflow under both the option given in question
Major Outflow Under Borrowing Option :
(i) Interest Paid Net Of Tax
(ii) Principal Repayment
Major Inflow Under Borrowing Option :
(i) Tax Saving On Depreciation
(ii) Salvage Value Adjusted for Tax on Capital Gain/Loss
Step 2 : Discount Rate : Kd = Interest Rate ( 1- tax)
Step 3 : Calculate Present Value Of Cash Outflow(PVCO) by using the discount rate.
BREAKEVEN LEASE RENTALS FROM THE VIEWPOINT OF LESSEE :

The break even lease rental is the rental at which the lessee is indifferent to a choice between lease financing and borrowing option.
At Breakeven Lease Rental :
PV Of Cash OutflowUnder Loan Option = PV Of Cash Outflow Under Lease Option
HOW TO EVALUATE FROM THE POINT OF VIEW OF LESSOR- AN INVESTMENT DECISION

While deciding whether to give asset on Lease or not,Lessor should undertake following steps
Step 1 : He should first evaluate the inflows and outflows
Major Outflow : Cost Of Asset
Major Inflow : Lease Rental Received Net Of Tax , Tax Saving on Depreciation , Salvage Value adjusted for tax.
Step 2 : Discount Rate : Ko = Cost Of Capital
Step 3 : Calculate NPV
Decision:If NPV is positive,then Lessor should give the asset on Lease otherwise he should not give.
EQUALANNUAL LOAN INCLUSIVE OFINTEREST :-

WHEN INSTALMENT IS PAID AT THE END OFEACH YEAR
Cost Of Asset ( or Loan Taken If It Differs)
For calculating Equal Annual Loan Inclusive Of Interest we will use following formula :
PVAF (r %, n years)
Where r = interest rate charged by bank before tax i.e Kd before tax.
EQUALANNUAL LOAN INCLUSIVE OFINTEREST :-

WHEN INSTALMENT IS PAID ATTHE BEGINNING OFEACH YEAR
For calculating Equal Annual Loan Inclusive Of Interest we will use following formula :
1  PVAF (r %, n - 1 years)
PRESENT VALUE OF INTEREST NET OFTAX & PRINCIPAL REPAYMENT MUST BE EQUALTO THE AMOUNT OF LOAN
PROVIDED DISCOUNT RATE IS KD
When discount rate is Kd then-PV of Interest Net Of Tax + Present Value Of Principal Repayment = Amount Of Loan
NETADVANTAGE OF LEASING (NAL)

NAL = Outflow Under Loan Option - Outflow Under Lease Option
Decision : If NAL is positive,Lease Option is preferred,otherwise select Loan Option.
EQUALMONTHLY INSTALMENT -WHEN INSTALMENT IS PAID ATTHE END OF EACH MONTH

Cost Of Asset ( or Loan Taken If It Differs) AADITYA JAIN
EMI = Where r = interest rate charged by bank before tax i.e Kd before tax.
PVAF (r % p.m, n x 12 periods)
EQUAL MONTHLY INSTALMENT -WHEN INSTALMENT IS PAID AT THE BEGINNINGOF EACH MONTH
EMI = 1  PVAF [r % p.m, (n x 12 periods - 1)]
ExamTips
NET PRESENT VALUE (NPV)
Formula :Net Present Value(NPV)= Present Value Of Cash Inflows - Present Value Of Cash Outflows
Accept/Reject Criterion :NPV > 0 Accept the proposal ; NPV = 0 Indifference point ; NPV < 0 Reject the proposal
Note : If question has not said specifically that which evaluation technique should be used , we will always prefer NPV Method..
RISK ADJUSTED DISCOUNT RATE (RADR)

Under this technique we discount the Cash Flows by a rate higher than Risk Free Rate .Such rate is known as Risk Adjusted Discount
Rate . Such rate is computed in the following manner
Alternative 1:(1 + Risk Adjusted Discount Rate )=(1 + Risk Free Discount Rate ) ( 1 + Risk Premium )
Alternative 2: It can also be calculated by using CAPM : Discount Rate = Rf + Beta x ( Rm - Rf)
Note : The Net Present Value computed by using Risk Adjusted Discount Rate is known as Risk Adjusted Net Present Value .
Note : Higher Risk should be discounted by higher rate.
CERTAINTY EQUIVALENT APPROACH (CEC)

Certainty Equivalent Approach involves discounting of Certain Cash Flows instead of the Total Cash Flows.
Steps In Certainty Equivalent Approach
Step 1 : Estimate the total future cash flows from the proposal. These cash flows have some degree of risk involved.
Step 2 : Calculate the Certainty Equivalent Coefficient (CEC) factors for different years .
The value of CEC can vary between 1 indicating no risk and 0 indicating the extreme risk. This means higher the risk, lower is the value
of CEC. (This value is generally given in question )
Step 3 : Multiply Total Cash Flows (Step 1) x CEC (Step 2) = Certainty Equivalent Cash Flows
Step 4 : Certainty Equivalent Cash Flows are discounted at Risk Free Rate to find out the NPV of the proposal.
EXPECTED NET PRESENT VALUE OR EXPECTED CASH FLOWS OR

EXPECTED VALUE
Expected NPV or Expected CF or Expected Value
=  Each possible outcome of an event  Probability of that outcome occuring
Example :
Estimated Value Probability Estimated Value  Probability
1000 .1 100
2000 .3 600
4000 .3 1200
3000 .2 600
5000 .1 _500
1 Expected Value/NPV/Cash Flow = 3000
Note:Probability Of All Outcomes will always be equal to 1
PROFITABILITY INDEX (PI) / BENEFIT COST RATIO / PRESENT VALUE INDEX / DESIRABILITY FACTOR
Present Value Of Inflows
Formula :Profitability Index (PI) 
Present Value Of Outflows
Accept/Reject Criterion :Where PI > 1 Accept the proposal ; PI = 1 Indifference point ; PI < 1 Reject the proposal
EFFECT ON CASH FLOW DUE TO INFLATION

The future cash flows can be either expressed as
(i) inclusive of inflation which are referred as Money Cash Flows
(ii) exclusive of Inflation which are referred as Real Cash flows
Conversion of Real Cash Flows into Money Cash Flows and Vice -versa :
Money Cash Flows
AADITYA
Money Cash flows = Real Cash Flows (1+ Inflation Rate) or Real CashJAIN
Flows = (1  Inflation Rate)
12.EFFECT OF INFLATION ON DISCOUNT RATE
Discount Rate can be expressed either as
(i) inclusive of future inflation which is referred to as Money Discount Rate
(ii) exclusive of future inflation which is referred to as Real Discount Rate
ExamTips
Conversion of Money Discount Rate into Real Discount Rate and vice versa :
(1+ Money Discount Rate ) = (1+Real Discount Rate ) ( 1+ Inflation Rate )
CALCULATION OF NPV WHEN INFLATION RATE IS GIVEN

Present Value may be found either by
(i) Discounting the Real Cash Flows at the Real Discount Rate or
(ii) Discounting the Money Cash Flows at the Money Discount Rate
In both cases resultant NPV would be same
Note : If question said that the value are given at "Current Prices " it means that these prices are given without taking the effect of inflation
.
COMPARISION IN CASE OF UNEQUAL LIFE / EQUATED ANNUALVALUE
If two projects have unequal life ,then the two projects are not comparable . To make them comparable we will use Equivalent Annual
Value Concept for each project by applying the following formula :
NPV or Present Value Of Cash Outflow or Present Value Of Cash Inflow
Equation:
PVAF( K %, n years)
Where K % = Discount Rate and n = Total Life of the project
PAY BACK PERIOD / PAY OFF PERIOD / CAPITAL RECOVERY PERIOD :IN CASE OF EVEN CASH FLOWS
Payback Period is the period within which the total cash inflows from the project equals the cost of the project.
Initial Investment
Formula :Payback Period =
Annual Cash Inflows
Decision : The project with the lower payback period will be preferred.
PAY BACK PERIOD / PAY OFF PERIOD / CAPITAL RECOVERY PERIOD : IN CASE OF UNEVEN CASH FLOWS
Remaining Amount
Formula : : Payback Period = Completed Years 
Available Amount
Decision : The project with the lower payback period will be preferred.
SENSITIVITY ANALYSIS / SCENARIO ANALYSIS - KEEPING NPV = 0

Meaning : Sensitivity Analysis enables managers to assess how responsive the Net Present Value is to changes in the variables or
factors which are used to calculate it .
Importance : It directs the management to pay maximum attention towards the factor where minimum percentage of adverse changes
causes maximum adverse effect.
Decision : If NPV were to become 0 with 2 % change in Initial Investment relative to 10 % change in Cash Inflows , Project is said to be
more sensitive to Intial Investment than to Cash Inflows .
Change
Symbolically : Sensitivit y (%)   100
Base
Some factors to be used under Sensitivity Analysis are Size of the project, Cash flows, Life of the project, Discount rate.
Under this analysis adverse effect of each input variable (parameters) is considered separately and all other variables are held
constant.
Factor Adverse Effect
Inflow Decrease
Discount Rate Increase
Outflow Increase
Life Decrease
SENSITIVITY ANALYSIS USING % ADVERSE VARIATION IN FACTORS

Under this method Sensitivity is calculated by takingAADITYA
adverse changesJAIN
by a specific % which will be indicated in question
The adverse factor for which % Fall In NPV is maximum is considered to be most sensitive.
Revised NPV - Original NPV
% Fall In NPV = 100
Original NPV
PROBABILITY OF OCCURRENCE IFTHE CASH FLOWS ARE (A) PERFECTLY DEPENDENT OVERTIME (B) INDEPENDENT
OVERTIME
ExamTips
The probability of occurrence of the worst or best case if the cash flows are
(a) Perfectly Dependent Overtime is Required Probability (b) Independent Overtime is (Required Probability) n
Where n = Life Of The Project
BETA OFA FIRM / FIRM BETA / OVERALL BETA OF FIRM / ASSET BETA / PROJECT BETA-IF TAX IS NIL
 Equity   Debt 
Overall Beta or Firm Beta or Asset Beta or Project Beta = Equity Beta   Debt  Equity  + Debt Beta   Debt  Equity 
   
BETA OFA FIRM / FIRM BETA / OVERALL BETA OF FIRM / ASSET BETA / PROJECT BETA-IF TAX IS CONSIDERED
Equity Debt (1 – tax)
Overall Beta or Firm Beta or Asset Beta or Project Beta = Equity Beta  + Debt Beta 
Debt(1 – tax)  Equity Debt (1 – tax)  Equity
LEVEREDAND UNLEVERED FIRM

If a company finances its investments and projects completely with Equity then the company is known as Unlevered Firm
If a company finances its investments and projects both with Equity and Debt then the company is known as Levered Firm
OVERALL COST OF CAPITAL ( KO)-IFTAX IS NIL

Alt 1 : K o  Risk Free Rate  Beta Overall [Market Return  Risk Free Return]
Alt 2 : K o  Cost Of Equity  Weight Of Equity  Cost Of Debt  Weight Of Debt  K e  We  K d  Wd
Where ,
K e  Risk Free Rate  Equity Beta ( Market Return  Risk Free Rate )  R f  B Equity ( R m  R f )
K d  R f  BDebt ( R m  R f )
OVERALL COST OF CAPITAL ( KO)-IFTAX IS CONSIDERED

K o  Cost Of Equity  Weight Of Equity  Cost Of Debt  Weight Of Debt  K e  We  K d  Wd
Where , K e  Risk Free Rate  Equity Beta ( Market Return  Risk Free Rate )  R f  B Equity ( R m  R f )
K d  Interest (1  Tax)
COST OF CAPITAL FOR UNLEVERED FIRM

Cost Of Capital = Cost Of Equity
OVERALLBETAFOR UNLEVERED FIRM

Overall Beta For Unlevered Firm = Equity Beta
DEBT EQUITY RATIO

Debt
Debt Equity Ratio = Equity
DEBT RATIO
Debt
Debt Ratio = Equity  Debt
EFFECT IN OVERALL BETA DUE TO CHANGE

AADITYA JAININ CAPITAL STRUCTURE
A school of thought led by Modigliani and Miller's theory believe that
THE
Overall Beta of the firm is not affected by theBEST
Change in SFM FACULTY OF INDIA
Capital Structure.
Overall Beta of a firm will be same as other company belonging to the same industry(sector) and it will not be effected by the Change in
Capital Structure.
EFFECT IN EQUITY & DEBT BETA DUE TO CHANGE IN CAPITAL STRUCTURE

Equity Beta and Debt Beta Changes with the change in Capital Structure
ExamTips
For example : Overall Beta of Idea Company will be same as Overall Beta of Airtel Company as both the company belong to the same
industry .But there Equity Beta and Debt Beta may be different at different Capital Structure .
TREATMENT OF WORKING CAPITAL

In the absense of information the students are advised to assume :
Introduction Of Working Capital at the beginning .This should be treated as Outflow.
Release Of Working Capital at the end . This should be treated as Inflow
Note : Changes in items such as Working Capital do not affect taxes.
Note : Any Increase in Working Capital should be treated as Outflow.
Note : Any Decrease in Working Capital should be treated as Inflow
HILLER 'S MODEL

When Cash Flows are Dependent or correlated : Standard Deviation of the project as a whole :
(SD1  PVF1 )  (SD 2  PVF2 )  .................. (SD n  PVFn )
When Cash Flows are Independent or uncorrelated :Standard Deviation of the Project as a whole :
(SD1  PVF1 ) 2  (SD 2  PVF2 ) 2  .................. (SD n  PVFn ) 2
BREAKEVEN UNITS
Fixed Cost
BEP refers to that volume of sales where the profit or loss is zero. Break Even Units =  100
Contributi on Per Unit
MODIFIED NPV
The Net Present Value calculated so far was based on an assumption that the cash inflow that is generated over the years is invested
at the same rate at which our cash flows are discounted . But this may not be true in all cases . It may so happen that the cash inflows of
the project may be invested at different rates . In such case we should compute Modified NPV as follows :
Find the Future Value of cash inflows at the given rate of investment for the remaining years.So if the project is for 5 years ,the cash
inflow generated in first year end shall be compounded for 4 years.Similarly the cash inflow generated in second year end shall be
compounded for 3 years and so on .
Take the total of future values which may be termed as Future Value or Terminal Value
Terminal Value
Find the Present Value Of Cash Inflows in the following manner :
(1  Cost Of Capital)n
Modified Net Present Value = Present Value Of Cash Inflows  Initial Cash Outflow
MODIFIED IRR
Modified IRR is the rate at which Modified NPV is zero.
THEORETICAL POST-RIGHTS (EX-RIGHT) PRICE PER SHARE
Theoretical Post-Rights (ex-right) or After Right Price Per Share =

MPS Cum Right  Existing No. Of Share  Right Share Price  No. of Right Shares
Existing No. Of Share  New Number Of Right Share Issued
THEORETICALVALUE OFTHE RIGHTSALONE

Alt 1:Value Of Right Per Share = MPS Before Right - MPS After Right
MPS Ex Right - Offer Price
Alt 2:Value Of Right Per Share = No. Of Shares In Respect
AADITYA JAIN
Of Which One Right Shares Are Issued
MPS AFTER RIGHT ISSUE IN CASE OF SYNERGY(NPV)
Existing MPS  Existing Share  Right Share Price  Right Shares  Synergy or NPV
MPS of the Project After Right Issue=
Existing No. Of Share  New Number Of Right Share Issued
ExamTips
FRA : HOW TO CALCULATE PROFIT/LOSS

Days in underlying rate
(Rate At Expiration - Forward Contract Rate) 
360 or 365
 FRA(Net Settlement) = Days in underlying rate
1 + Rate at expiration x
360 or 365
HOWTO CALCULATE EVA

Symbolically : EVA = Net Operating Profit After Taxes - Cost Of Capital Employed
Where Net Operating Profit After Taxes [NOPAT] = EBIT(1 - Tax)
Cost Of Capital Employed = Cost Of Capital  Capital Employed
Cost Of Capital (Ko) or Weighted Average Cost of Capital(WACC) = K e  We  K r  Wr  K d  Wd  K p  WP
Note : In Calculating Operating Profit,interest is not deducted as interest is a non-operating items.
Note : Total Funds / Capital Employed includes : Equity Share Capital + Reserves + Debentures +Preference Share Capital +Long Term
Loan - Profit and Loss Account ( Dr.) - Fictitious Asset
Earning or Profit Before Interest and Tax [EBIT]
Note : Financial Leverage = Earning or Profit Before Tax [EBT]
Note : EBT = EBIT - Interest
MARKETVALUE ADDED(MVA)
MVA is yet another concept which is used to measure the performance and value of the firm .
Symbolically :
From Equity Point Of View
MVA =Current Value of the securities of the Company in the Market - Total Amount of Shareholder's Funds[Balance Sheet Fig. ]
Note: Shareholder's Funds[Balance Sheet Fig.]includes Equity Share Capital + Retained Earning - Accumulated Loss - P/L Account (
Debit Balance )
From Overall Company's Point Of View
MVA = Value of the Company Based On Free Cash Flows - Total Capital Employed or Amount Invested
INTEREST COVERAGE RATIO (ICR)

A ratio used to determine how easily a company can pay interest on outstanding debt.
EBIT
Interest Coverage Ratio = Interest Expense
The lower the ratio, the more the company is burdened by debt expense. An interest coverage ratio below 1 indicates the company is
not generating sufficient revenues to satisfy interest expenses.
Decision: Higher the better
CAPITALGEARING RATIO (CGR)
Fixed Income Bearing Funds (Preference Share Capital  Debentures  Long Term Loan)
Formula:Capital Gearing Ratio = Equity Shareholders' Fund = (Equity Share Capital  Reserves & Surplus - Losses)
Decision: Lower the better
FIXED INTERESTAND DIVIDEND COVERAGE
PAT  Debenture Interest
Interest and Fixed Dividend Coverage =
Debenture Interest  Preference Dividend
Decision: Higher the better
EXPONENTIALMOVINGAVERAGE (EMA)
Formula: EMA = EMA yesterday + a x [ Price Today - EMA Yesterday ] Where a = Smoothing Constant / Multiplier.It will be normally
given in question .If not given than it can be calculatedAADITYA JAIN
by using a = 2/(N+1) where N is the number of items in the average.
SHARPE'S OPTIMAL PORTFOLIO/APPLICATION OF CUT OFF POINT
1.Find out the “excess return to beta” ratio for each stock under consideration.
2.Rank them from the highest to the lowest.
3.Proceed to calculate Cut Off Point Of Security (Ci) for all the stocks according to the ranked order using the following formula:
ExamTips
N (R – R )  β
σ2m  i f i
i 1 σ2
Ci  ei
N β 2
1  σ2m  i
2
i 1 σ ei
Where σ 2 ei = variance of a stock’s movement that is not associated with the movement of market index i.e. stock’s unsystematic risk.
The highest Ci value is taken as the cut-off point i.e. C*.It is the cut off rate.Security with C* value and the securities before this security
are to be included in the portfolio and others are rejected.
βi  R i  R f 
4.The next step is to calculate weights.For this purpose we have to calculate Zi. :Zi =   C* 
2
σ ei  β i 
By using Zi ,weights are calculated.
VALUE OF EQUITYAS PER RISK PREMIUM APPROACH
Actual Yield Of The Company
Value of Equity Share =  PaidUp Value Per Share
Expected Yield Of Industry Adjusted According To Risk
Yield On Shares
Actual Yield On Equity Shares(%)  100
Equity Share Capital
BOND IMMUNIZATION
A portfolio is immunized when its duration equals the investor’s time horizon. In other words, if the average duration of portfolio must
be equals the investor’s planned investment period.
A portfolio is immunized when it is “unaffected” by interest rate changes.
TEST OF HYPOTHESIS/RUN TEST /DEGREE OF FREEDOM

Step-1:First Calculate Mean Value of r & Standard Deviation in the following manner
2n1n 2 2n1n 2 (2n1n 2  n1  n 2 )

Mean Value Of r  n  n  1 ; Standard Deviation 
1 2 (n1  n 2 ) 2 (n1  n 2  1)
Here n1 refers to total number of positive changes ;n2 refers to total number of negative changes.
Step-2: Calculate Standard Lower & Upper Limit in the following manner :
The Standard Lower limit = Mean Value Of r - Table Value x SD
The Standard Upper limit = Mean Value Of r + Table Value x SD
Step-3: Decision:If our value of r lies within the standard lower limit and standard upper limit,the randomness is there i.e the market is
weakly efficient,otherwise it is not weakly efficient.
Here r refers to number of times sign changes
Note:Table Value or Degree Of freedom should be selected in following manner :n1+n2-1
AADITYA JAIN
ExamTips
AADITYA JAIN
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EARNING PER SHARE (EPS)

DIVIDEND PER SHARE (DPS)

MARKET PRICE PER SHARE (MPS)

DIVIDEND PAYOUT RATIO (D/P RATIO)

EARNING YIELD (EY)

RELATIONSHIPBETWEEN GROWTH RATE ; RETURN ON EQUITY ; RETENTION RATIO

DETERMINATION OF GROWTH RATE (g)

(b) D Latest or Current  D Base (1  g) n -1

ZERO GROWTH RATE

P0 [ Assuming Dividend is growing constantly from year 4 onwards ]

OVERVALUED & UNDERVALUED SHARES

RELATIONSHIP BETWEEN KE & PE RATIO

Return On Equity (ROE ) ( r)

RELATIONSHIP BETWEEN ROE,BVPS & EPS

CALCULATION OF HOLDING PERIOD RETURN(HPR)

STRATEGY WHEN INVESTOR IS ALREADY HOLDING SHARES

E/P RATIO OR EARNING PRICE OR YIELD RATIO

VALUE AS PER PE MULTIPLE APPROACH AND

VALUE OF STRAIGHT COUPON BOND OR EQUAL COUPON BOND

VALUE OF PERPETUAL BOND ORJAIN

Value Of Bond (B0 )  THE

VALUE OF ZERO COUPON BOND OR DEEP DISCOUNT BOND

HOLDING PERIOD RETURN (HPR)

Lower Rate NPV

RELATIONSHIPBETWEEN BOND VALUE AND YTM

RELATIONSHIP BETWEENYTM AND COUPON RATE

TAXATION EFFECT ON INTEREST INCOME

DURATION OF PERPETUAL BOND

1  Interest Interest Interest Maturity Value 

DURATION OFA ZERO COUPON BOND

VOLATILITY /SENSITIVITY/MODIFIED DURATION

FAIR VALUE OF CONVERTIBLE BONDS AS ON TODAY/STOCK VALUE OF BOND

PERCENTAGE OF DOWNSIDE RISK

CONVERSION PARITY PRICE PREMIUM PER EQUITY SHARE

FAVOURABLE INCOME DIFFERENTIAL PER SHARE

PREMIUM PAY BACK PERIOD

COST OF REDEEMABLE PREFERENCE SHARES

 Maturity Value – PSC 0 

COST OF IRREDEEMABLE PREFERENCE SHARES

VALUE OF REDEEMABLE PREFERENCE SHARES

VALUE OFBOND UNDER REINVESTMENT CONCEPT

CALCULATION OF BO WHEN ENTIRE PRINCIPAL & INTERESTAMOUNT IS RECEIVED AT MATURITYYEARS

Face Value(1  Coupon Rate) n

CALCULATION OFYTM OF HALFYEARLY

NETASSET VALUE (NAV)

Net Asset Total Asset - Total External Liability

HOLDING PERIOD RETURN(HPR)

DIVIDENDYIELD METHOD OR DIVIDEND CAPITALIZATION VALUATION METHOD

Dividend Per Share (DPS)

EARNINGYIELD METHOD OR INCOME OR EARNING CAPITALIZATION VALUATION METHOD

Earning Per Share (EPS) AADITYA JAIN

PRESENTATION OF INCOME STATEMENT TO CALCULATE MPS

VALUE OF FIRM USING FUTURE MAINTAINABLE PROFITS(FMP)

Calculation Of Future Maintainable Profits :

PRICE EARNING [P/E] RATIO VALUATION METHOD

NETASSET VALUATION METHOD

DISCOUNTED CASH FLOW(DCF) APPROACH/FREE CASH FLOW APPROACH

CHOICE OF CORRECT DISCOUNT RATE WHILE CALCULATING VARIOUS VALUES

SHARE EXCHANGE RATIO BASED ON EPS

SHARE EXCHANGE RATIO BASED ON MPS

SHARE EXCHANGE RATIO BASED ON BOOK VALUE PER SHARE (BVPS)